Are Offshore Pension Schemes aware of their UK income tax liabilities?

The introduction of the UK Trust Register has given rise to some interesting and worrying conversations for offshore pension providers. The Trust Registration guidance makes it clear that HMRC is not looking to include pension schemes within the registration rules despite almost all pension schemes being “express” trusts per the legislation. However, the exclusion is only for UK registered pension schemes. What about non-UK resident pension schemes with UK investment assets? Quite simply, they are trusts and are within the rules.

This gives rise to a further question: if a non-UK pension scheme that is not a registered pension scheme under the HMRC definition holds UK investments, is it liable to UK income tax? The answer is “maybe” or more probably “yes”, if there are scheme members or potential members who live in the UK!

Disregarded Income rules

The UK tax legislation limits the UK sourced income on which a non-UK resident must pay income tax. The income that is exempt is known as disregarded income. However, non-resident trusts with UK resident beneficiaries cannot rely on the disregarded income exemption if any income under the trust may be paid to or used for the benefit of a person in the exercise of a discretion conferred by the trust.

The UK resident member will be entitled to receive a pension in the future and so will be entitled to receive benefits paid out of income earned by the scheme. The critical question will be whether future potential benefits will be provided by the pension scheme as a consequence of a discretionary power being exercised. That is less clear.

Discretionary trustee powers?

A pension scheme that is open to the public to join and offers comprehensive and defined rights is unlikely to grant the scheme administrators any discretionary powers. In contrast, pension arrangements intended to provide benefits to single members and their immediate family, of the type typically seen with FURBS, EFRBS and QNUPS, are more likely to give the pension trustees powers that are discretionary in nature. For example, the trustees may have the power to decide what happens to the pension assets on the death of the principal member. If so, the ability for the trustees to decide whether and how to pay out future benefits out of UK sourced income to future potential beneficiaries will mean that the trustees are liable to tax in the UK on any UK sourced income.

There may be trustees of non-UK pension schemes holding UK investments who believe that any income they receive is exempt from tax in the UK, but they will have current and historic UK tax liabilities that need to be reported to HMRC. The added jeopardy for those trustees is the Failure to Correct penalty regime that allows HMRC to charge penalties of up to 200% of any tax lost with the potential for those penalties to be increased in certain circumstances.

Action required

Trustees or scheme administrators of non-UK resident pension schemes should review their schemes for any UK sourced income in order to identify the potential for potential UK income tax liabilities. Trident Tax will be happy to help trustees to understand their UK tax position. There are straightforward solutions to prevent UK sourced income being subject to income tax in the UK to prevent future liabilities accruing.

There is a relief from capital gains tax which was introduced for shares subscribed for on or after 17th March 2016, and held for at least three years. Therefore, no-one has yet been able to claim this relief, and investors may have forgotten about it. A disposal of shares made after 17th March 2019 could qualify for a lower CGT rate of 10%, rather than 20%, if it qualifies for “Investors’ Relief”.

There is a lifetime limit on gains that can be relieved of £10m, so the rate and limit are similar to Entrepreneurs’ Relief. However, for Investors’ Relief, the individual must not have been an employee during the three year period, nor can anyone connected with him have been an employee. The relief is of no help to an individual who hoped to get Entrepreneurs’ Relief but has failed those conditions.

The shares must be in an unquoted trading company, or an unquoted company which is the holding company of a trading group.

The shares must have been acquired by subscription rather than purchase, and there are detailed conditions similar to those for an investment to qualify for Enterprise Investment Scheme relief.

A seller of shares may not have control of the timing of the disposal, but it would be worth knowing whether or not the relief is available. Trident Tax can advise you on whether your shareholding would qualify.

In the 2018 Budget, the government announced a proposal to charge an extra 1% SDLT on non-UK residents buying UK residential property. The proposed definition of a non-UK resident individual for this purpose is a person who has spent less than 183 midnights in the UK in the 12 months ending on the date of the transaction, according to the consultation document issued on 11th February 2019. (There is no date for the provision coming into effect, the consultation ends on 6th May).

Then a person who spends more than 183 midnights in the UK in the 12 months following the date of the transaction can apply for a refund. Presumably this is to allow someone who moves into the house they’ve bought in the UK to be taxed as a resident rather than a foreigner.

If two individuals buy a house as joint owners, and one of them is not UK resident at the time under the SDLT test, then the extra 1% applies to the whole of the consideration.

The 1% charge is in addition to the SDLT due in relation to other factors. So, for example, an individual who is non-UK resident and already has a residence would pay the 1% in addition to the 3% additional SDLT on second home owners.

The proposed test for an individual needs to be one which can be applied on a particular date, and it is therefore not the same as the Statutory Residence Test for income tax and capital gains tax, which applies for a tax year. This means in particular that it is perfectly possible for a person who is UK tax resident in 2019/20 to be treated as a non-UK resident when they buy a property on 5th April 2020.

The consultation document notes that these rules are intended to be “as simple as possible for taxpayers and conveyancing solicitors to apply, in recognition of the fact that most people buying a home will not engage a professional adviser.” What this means is that the rules for “non-natural persons” are even more complicated.

Where an offshore trust acquires a UK residential property, the rules which use the residence of the trustees and settlor in order to determine the residence status of the trust will apply, however where the test considers whether an individual trustee is UK resident or not, the test will be the same as for a non-UK resident individual for SDLT purposes. That is, the residence of the trustee is considered by reference to his midnights spent in the UK in the twelve months prior to the transaction.

Where a company acquires residential property, it already pays SDLT at 15% (subject to exemptions), however if the company is treated as non-UK resident for SDLT purposes, this will increase the rate to 16%. The normal test of company residence is applied to determine whether the company is UK resident or not at the time of the transaction. However, there is a further category of companies which will pay the additional 1%. The rate applies to a company which is itself UK resident, but which is a close company controlled by one or more non-UK resident individuals. This is said to be to ensure that non-UK resident individuals can’t avoid the extra 1% by acquiring through a UK company, even though that could itself result in a 15% charge.

Although SDLT is payable only on property in England and Northern Ireland, the test applies to nights in the whole of the UK; thus a Scot who buys an English property should not be taxed as a foreigner.

The taxpayers have recently lost a First Tier Tribunal case relating to an inheritance tax liability, Nader, Dickins, Gill & others v HMRC [2018] UKFTT 294. The circumstances are described as a “death-bed avoidance scheme”, but there are likely to be many other taxpayers who are affected. The interpretation of the exemption for a disposition which was not intended to confer a gratuitous benefit taken in the case is a restrictive one. The reasoning in the case also appears to have consequences for capital gains tax.

In 2010, an individual paid £1,075,000 for an “income interest” in a discretionary trust which had been settled by a non-UK domiciled individual and was thus expected to be an excluded property trust, so the trust interest would be outside the scope of UK inheritance tax. (This was before the amendment to the legislation with effect from 20th June 2012 which prevented an acquired interest from being excluded property). The income interest was not an interest in possession, but a right to call annually for the trust income. The trustees also agreed to amend the class of discretionary beneficiaries to comprise the purchaser’s family rather than the settlor’s family, although this was not actually done until after the purchaser’s death.

The tribunal found against the individual’s executors on a number of grounds, some of which have wide application.
• They held that the purchase of the trust interest was a transfer of value, despite the fact that it was purchased from an unconnected person, because the trust interest was not worth the sum paid for it.
• They held that the exemption for transactions (including associated operations) not intended to confer gratuitous benefit was not available, because although the purchase of the trust interest was between unconnected persons, in these circumstances, it was not on arm’s length terms. Again, the fact that the income interest was not worth the sum paid was relevant. The wider implication here is that where a transaction is undertaken to obtain a tax benefit, but the transaction does not make commercial sense otherwise and the taxpayer loses value, then this can be a chargeable transfer.
• They held that the individual was a settlor of the trust. The particular circumstances here were that although the trust existed at the time when she agreed to purchase the income interest, the vast majority of the funds were settled after she agreed to purchase the interest. Thus, although she did not fund the settlement, she was regarded as the settlor when the situation was “viewed realistically”. They held that for inheritance tax there was no requirement for an element of bounty. The wider implication of this is that since she was UK domiciled, almost none of the trust assets were excluded property.
It seems to us that this “realistic” approach to who is the settlor could result in a purchaser of a trust interest being treated as a settlor for the purposes of section 86 TCGA 1992, and the settlor being assessable on trust gains as they arise. This would extend to gains in close companies whose shares are held in the trust, subject to any claim to the section 13(5)(cb) motive defence.

In our view, the following groups of UK domiciled people should review their tax position as a result of this case:
• Anyone who has acquired an interest in an excluded property trust before June 2012.
• Anyone who has undertaken an inheritance tax planning scheme where reliance was placed on a payment to a third party not being a transfer of value or being an exempt transfer of value
• Anyone who has acquired an interest in an excluded property trust, where they have not then reported taxable gains in the trust or an underlying company.
Someone in this position could have historic tax liabilities, including an inheritance tax charge on the transfer of value when the trust interest was purchased and subsequent capital gains tax liabilities.

Many taxpayers in this position will not have been able to obtain advice on this issue before the requirement to correct deadline on 30th September 2018. We recommend that specialist advice is taken as soon as possible to consider the best approach to rectifying their position.

Hundreds of multinationals will now have received a letter from HMRC, suggesting that they register for the new Profit Diversion Compliance Facility. Those who don’t register are more likely to receive formal enquiries from HMRC.

Those who receive the letter are groups that HMRC consider may have used incorrect transfer pricing in areas targeted by Diverted Profits Tax. HMRC say that they have a growing list of multinationals who could be diverting profits, and who they plan to investigate.

Although this tax was described as “the Google tax”, I know from my work leading KPMG’s response to Diverted Profits Tax back in 2015 that it has potential applications to a much wider group of companies than just technology companies. There are issues for retail groups selling high-tech products to industry and to individuals, fashion groups, investment funds, captive insurers etc. (The facility does not apply to groups where non-UK resident companies deal in or develop UK land).

The disclosure process

The opportunity to register is open until 31st December 2019 and registering immediately in response to a letter may not be a good idea. A group which registers will discover that it has 6 months to produce a report in the specified format, which includes calculations of tax, interest and penalties. The taxpayer is required to pay the tax due when they submit the report, while HMRC aim to respond to the report within 3 months. The breadth and depth of the required report makes 6 months to prepare it an extremely challenging target.

Before the Requirement to Correct deadline, we saw trusts and individuals making protective registrations where they were unsure of their technical or factual position, using the time before the disclosure report was due to finalise their analysis. But the amount of work which is required to make a disclosure under this new Facility is so extensive with such a tight time limit that this seems to be inadvisable here.

Which accounting periods would a disclosure under the Facility cover?

Diverted Profits Tax is an unusual tax, because amending your corporation tax computation to transfer pricing agreed by HMRC generally means that no Diverted Profits Tax is payable. This is referred to in the HMRC guidance. Since the DPT rate is higher than the corporation tax rate by 6%, most groups opt to amend the corporation tax return. However, this means that the group may end up having to amend returns or make voluntary disclosures for periods before the introduction of Diverted Profits Tax in 2015, because if they have used the same Transfer Pricing policy in earlier years’ computations, then these too may be regarded by HMRC as incorrect.

Because of the various assessing time limits, a group needs to establish how HMRC will characterise its behaviour before it can decide which accounting periods the report needs to cover- HMRC can assess earlier periods if the behaviour is “careless”, as that term is interpreted. The guidance specifically says that taking transfer pricing advice is not, of itself, sufficient to demonstrate that reasonable care has been taken.

Investigating your own transfer pricing

The most significant benefit of registering for the Facility is that any penalties should be calculated on the basis that the group has made an unprompted voluntary disclosure, i.e. at a lower level than would have been charged on penalties arising as a result of an HMRC investigation.

There is also a benefit in that HMRC will not launch an investigation. However, this in effect means that the group is required to investigate itself, to the same depth as HMRC would have investigated it. The Facility sets out the extensive scope of the report which is to be prepared, and the extent of the factual research which is required to support it; the scale of work required should not be under-estimated.

HMRC set out some of the areas where they have found groups’ transfer pricing policies and implementation to be inadequate. These include the following;

Transfer pricing that is out of date in relation to the group’s current business and functions. (This can occur in particular where a transfer pricing analysis relied on UK individuals working in another country, and they drift back to working in the UK).

Transfer pricing that is “old-fashioned” in relying on contractual allocation of risk to low-tax jurisdictions, rather than looking at significant people functions.

Transfer pricing analysis that is built on an incorrect factual foundation.

The guidance says that the action required includes interviewing staff and checking contemporaneous emails, not just producing the transfer pricing documentation.

Include a detailed section of the other international tax matters HMRC require, including company residence in the UK, permanent establishments in the UK, deduction of withholding tax, treatment of CFCs, and indirect tax, which will withstand HMRC scrutiny.

Quantify any tax adjustments arising from this, again establishing which accounting periods HMRC can assess

Determine how HMRC will characterise the group’s behaviour for penalty purposes and calculate any penalties due, including failure to notify re Diverted Profits Tax

All these workstreams will have to be project managed carefully to produce the report within 6 months of registering.

Risks not covered by registering under the Facility

HMRC list certain actions which they may still take against a group which registers for the Facility but does not make a full and accurate disclosure, i.e. where HMRC consider that the disclosure report is inadequate or inaccurate. This includes launching a CoP 9 enquiry or making criminal charges.

The quality of the disclosure is important in protecting the Senior Accounting Officer given that the group may admit careless behaviour: HMRC say that the business is required to make a full and accurate disclosure and co-operate fully.

Use of advisors

Groups who use a team from their auditor for their transfer pricing advice may find that the audit firm cannot represent them in relation to the disclosure because of independence requirements.

Apart from the transfer pricing and Diverted Profits Tax analysis, a group would also require an advisor who brings the expertise to advise on:

The scope of the transfer pricing investigation necessary to prepare the report

The scope of the investigation into the other international tax issues necessary to prepare the report

The characterisation of the group’s behaviour for assessment and penalty purposes

The risks in relation to fraud and the position of the Senior Accounting Officer

Negotiation with HMRC

Once a group has registered, HMRC say that they are willing to meet with them to discuss in advance their plans for the review and report. Would you want to walk into such a meeting without an experienced investigations specialist by your side? Trident Tax would be happy to help.

On 4 December 2018, the House of Lords Economic Affairs Committee published its report ‘The Powers of HMRC: Treating Taxpayers Fairly’ (‘the report’).

The report included a series of conclusions, recommendations and some stinging criticisms of HM Revenue & Customs (‘HMRC’) which were widely reported at the time (see for example: Tax Journal, ICAEW, BBC).

This article focuses on one key aspect of the report, the 2019 Loan Charge. In particular, a recommendation to change the current legislation. This recommendation, in our view, has been under-reported to date and requires HMRC and the Government to clarify their intentions urgently.

It is worth quoting the recommendation here in full:

We recommend that the loan charge legislation is amended to exclude from the charge loans made in years where taxpayers disclosed their participation in these schemes to HMRC or which would otherwise have been ‘closed’.

This recommendation was made in the context of broader criticisms of both the 2019 Loan Charge legislation and HMRC’s approach to dealing with ‘disguised remuneration’ cases.

These included:

The retrospective effect of the legislation which undermines normal time limits for tax assessments and diverges substantially from established principles (notably those in the 2005-2012 Powers Review).

HMRC’s disproportionate approach to pursuing taxpayers (including inappropriate threats of bankruptcy) and failure to communicate its position in a clear or timely manner.

The following simple example, which is not uncommon in our experience, illustrates why urgent clarification is required.

An individual entered into a ‘disguised remuneration’ arrangement in 2008. The arrangement involved the individual’s employer making a contribution into an Employee Benefit Trust (‘EBT’) the proceeds of which were then allocated into a sub-Trust specifically for the benefit of the individual. The sub-Trust then made a loan to the individual.

The law, as it was understood at the time, would prevent the employer deducting the contribution in calculating its taxable profits for the period but neither the contribution nor the loan would be taxable as the individual’s earnings from employment (although if the loan was interest free there would be a taxable benefit arising equal to notional interest at HMRC’s official rate).

The arrangements were fully disclosed in the employer’s accounts and tax returns, and in the individual’s tax returns. However, HMRC failed to make an assessment on either the employer (for PAYE) or the individual (for Income Tax) within the statutory time limit for doing so.

The loan remains outstanding and the individual is unable to repay the loan before 5 April 2019.

Under the 2019 Loans Charge legislation the unpaid loan is treated as becoming employment income on 5 April 2019, in respect of which the employer must account for PAYE & NIC. If the employer does not pay, it is expected that HMRC will issue a Regulation 80 Determination for the PAYE. If it becomes clear the employer cannot pay, HMRC will seek a Direction under Regulation 81(3) to make the individual borrower personally liable for the Income Tax. If the employer entity no longer exists, the individual must declare the unpaid loan as employment income on their 2018/19 personal tax return.

To avoid the 2019 loans charge arising and within the terms of HMRC’s settlement guidance, the individual must agree to make ‘voluntary restitution’ of the Income Tax on the original amount allocated to the sub-trust as if it were earnings (even though HMRC cannot collect the tax in law) before 5 April 2019, otherwise a charge to Income Tax will arise on that date (possibly at higher rates). Additionally, although there is no legal mechanism to transfer the liability, HMRC’s settlement terms also require the individual to settle the Employers’ NIC.

The Lords Committee recommendation (above) clearly states that in their view the legislation must be changed so that an individual in these or similar circumstances will not face a 2019 Loan Charge: either because a full disclosure was made at the time; or that the period in which the EBT contribution was made is now ‘closed’; or both.

In light of the above some key questions arise, including the following:

Should an individual in these or similar circumstances agree to make ‘voluntary restitution’ to prevent a 2019 Loan Charge which the Lords’ Committee states should not arise?

Is it appropriate, in these circumstances, for HMRC even to enter into agreements for ‘voluntary restitution’ until the position is clarified?

If the Government accepts the Lords Committee recommendation and changes the legislation to exclude these and similar cases from charge, what happens to those cases where individuals have already entered into ‘voluntary restitution’ agreements e.g. should HMRC repay the amounts to the individuals?

At the time of writing this article, the only Government response which could be identified was reported by the BBC to be as follows (from a ‘Government Spokesperson’):

“On the loan charge in particular, it is important to bear in mind that disguised remuneration schemes are aggressive tax avoidance structures that allowed some people to avoid the taxes that Parliament requires them to pay.”

The ICAEW reports that Mel Stride, Financial Secretary to the Treasury, did not give evidence to the Lords Committee but will respond to the Committee formally in writing: at the time of writing this article, no such response has been made public.

We therefore call on the Government and HMRC to make the position clear urgently to provide certainty for advisors and taxpayers in this difficult and controversial area.

If you would like help with any of the issues raised in this article, contact us here.

HMRC guidance on cryptoassets means that all 2017/18 profits should be shown on the tax return and tax paid at the end of next month

HMRC have issued updated guidance, and presumably this means that they expect 2017/18 returns to be submitted on this basis, and capital gains tax liabilities to be paid on this basis on 31st January 2019. This tax is due even where one currency was exchanged for another in 2017/18 and the currency acquired has fallen dramatically in value, so the individual may not have cash proceeds to meet the tax. Crypto losses in 2018/9 cannot be set against the gains to reduce the tax payable.

The most significant statement in the new guidance is “HMRC does not consider the buying and selling of cryptoassets to be the same as gambling”. Their previous guidance said “Therefore, depending on the facts, a transaction may be so highly speculative that it is not taxable or any losses relievable. For example gambling or betting wins are not taxable and gambling losses cannot be offset against other taxable profits.” This had led some owners to believe that they did not need to report gains.

The new guidance makes it clear that most gains are subject to capital gains tax, and “only in exceptional circumstances” will a gain be subject to income tax. Both gains and income need to be reported, and there is no de minimis. This then means that losses will be capital losses, and so in particular, losses realised in 2018/19 may be difficult to use, as they can only be carried forward against gains in later tax years or offset against gains on other assets in 2018/19.

The guidance repeats HMRC’s previous comment in the Capital Gains Manual that gains on cryptocurrencies should be calculated on a “pooling” basis. Owners may not agree with HMRC’s comment that this “allows for simpler Capital Gains Tax calculations”. It requires that all transactions in one currency are calculated by pooling all of the acquisition costs, and then each sale or gift of currency is treated as a part-disposal of the pool. In particular, this means that owners who held a currency at 6th April 2017 will need to calculate the pool for earlier years in order to complete their 2017/18 return. Online “Crypto calculators” may well not use this method and thus cannot be used for UK returns.

There is a section on record keeping as follows.
“Cryptoasset exchanges may only keep records of transactions for a short period, or the exchange may no longer be in existence when an individual completes a tax return.
The onus is therefore on the individual to keep separate records for each cryptoasset transaction, and these must include:
• the type of cryptoasset
• date of the transaction
• if they were bought or sold
• number of units
• value of the transaction in pound sterling
• cumulative total of the investment units held
• bank statements and wallet addresses, if needed for an enquiry or review”

“Value of the transaction in pound sterling” may be a difficult calculation. HMRC say “If the transaction does not have a pound sterling value (for example if bitcoin is exchanged for ripple) an appropriate exchange rate must be established in order to convert the transaction to pound sterling.

Reasonable care should be taken to arrive at an appropriate valuation for the transaction using a consistent methodology. They should also keep records of the valuation methodology.”

The key point here is that capital gains tax is due even where one cryptocurrency has been exchanged for another, and the owner has received no cash.
On normal rules, where a gain is taxed on the basis of the value of the new currency, there is no deduction in this calculation for the further transaction costs that could be incurred in actually receiving this value into a UK bank account.

In our previous article (click here), we talked about groups setting up DLT companies in jurisdictions which already have a regulatory framework, such as Gibraltar. A group which is working on applying DLT to its business will be creating intangible assets, and will therefore need to look at the tax issues which apply to such activity. There are a number of countries which have specific innovation regimes. However, one of the key factors is where the group has staff with the capability to develop these intangible assets, since transfer pricing within the group will focus on where the functions which create value are actually being undertaken. If it is not possible to move the staff to the countries offering an “innovation box”, then the tax benefits will be difficult to access.

This article considers the situation where the staff within a group who will develop DLT are located in the UK, while the ownership of the technology is in the DLT company in, for example, Gibraltar.

If UK staff within the group work for the Gibraltar DLT company, then HMRC may consider that the Gibraltar company has a UK permanent establishment, to which taxable profits should be attributed. There is a further issue specific to the UK. If the Gibraltar DLT company has “avoided a taxable presence in the UK”, while there is UK activity in relation to sales, then it could be subject to UK corporation tax at a higher rate of 25%, under the Diverted Profits Tax, if the group is “large”.

If a UK company participates in developing the intangible assets of the Gibraltar DLT company then HMRC are likely to argue that it should be reimbursed by a share of profits, rather than on a “cost plus” basis. For a UK company which is “small or medium sized”, transfer pricing does not generally apply. However, it does still apply to provisions between the UK and “non-qualifying” territories. In particular, transfer pricing would apply to work on developing DLT undertaken in the UK, where the DLT company is located in Gibraltar or Cayman, which have DLT regulatory frameworks.

For example, if a group is considering using staff of a UK company to develop the DLT software for the Gibraltar DLT company, then there are likely to be substantial UK taxable profits arising if the DLT business is profitable. It is then worth considering whether research and development (R&D) tax relief is likely to be available. There is no requirement that the UK contracting company should own the IP which it develops. In general, a UK company which is contracted to provide services to a group DLT company can claim RDEC (R&D expenditure credit), and this claim can be made even where the company is not yet making taxable profits.

For R&D relief to be available on software, the development must directly contribute to achieving an advance through the resolution of scientific or technological uncertainty, and there must be an advance in overall knowledge or capability in a field of science or technology, not just the company’s own state of knowledge or capability alone. Pioneers in DLT technology may well expect to meet these conditions.

In conclusion, if the technology for a Gibraltar DLT company is being developed in the UK, then the profits attributable to the UK activity need to be considered on transfer pricing principles, even for a small or medium sized group. Equally, the potential tax benefits of R&D credits in the UK should not be overlooked; they could be particularly valuable to the group in the pre-revenue stage of its development.

Does the government, or more importantly, HMRC, take any notice of what the House of Lords has to say?

Thousands of employers and individuals who used disguised remuneration schemes and are facing a new tax charge on 5 April 2019 will be hoping so. The Economic Affairs Committee of the Lords has delivered a hard-hitting critique of HMRC’s conduct in relation to disguised remuneration schemes, amongst several other topics.

As many have previously commented, the Lords found the retrospective effect of deeming loans made up to 20 years ago as employment income on 5 April 2019 to be unacceptable. The committee noted that the effect of the new charge is effectively to walk around the statutory time limits that HMRC have failed to meet in many cases. It seems clear that the intention of HMRC was to ensure that it had a second bite at the cherry where it had failed to open enquiries or make protective assessments within the specified time limits.

In advance of the DR loans charge, we have also seen examples of HMRC making Regulation 80 PAYE Determinations in disguised remuneration cases very close to the end of the 6 year time limit which applies where there has been a loss of tax due to careless behaviour. However, when the issues are properly evaluated it appears that in some cases HMRC are seeking to make generic assumptions about the conduct of taxpayers and/or their professional advisers without sufficient evidence to support such a view.

The Lords also considered that HMRC sometimes aggressive pursuit of taxpayers was not proportionate and diverged substantially from the principles on which it should operate according to the Powers Review. The evidence given by HMRC was that only 5,000 of an expected 50,000 cases had already reached settlement. The average employer settlement was £525,000 whilst the average individual settled for £23,000.

One positive to take from this is that if HMRC can be persuaded to take a more proportionate approach, there are many taxpayers who could still benefit from this.

In particular, the Lords were “disturbed to hear accounts of HMRC threatening individuals with arrangements that could result in bankruptcy, where individuals clearly have no assets to settle liabilities. Whether these threats were explicit or perceived, they have caused considerable anguish for a number of individuals.”

The Lords made a number of very specific recommendations, including

– that the loan charge legislation is amended to exclude from the charge loans made in years where taxpayers disclosed their participation in these schemes to HMRC or which would otherwise have been “closed”

– that HMRC urgently reviews all loan charge cases where the only remaining consideration is the individual’s ability to pay

– that HMRC establishes a dedicated helpline to give those affected by the loan charge advice and support. Such action should take place well in advance of the loan charge coming into effect in April 2019.

Although the conclusions and recommendations of the Lords will be welcomed, whether they will have any practical effect is a question that will be answered by the approach of HMRC in the coming months. However, it is only right that these points are made to HMRC in the course of correspondence and discussions with HMRC when negotiating settlements and time to pay in disguised remuneration cases.

If you would like to discuss a disguised remuneration case please contact us.

One of the key conditions for Entrepreneurs’ Relief on shares or an interest in shares is that the company needs to have been the individual’s “personal company” in the period of a year leading up to either the sale of the shares, or the company ceasing to be a trading company or the holding company of a trading group. For disposals from 6 April 2019, the one-year period is extended to two years. Simple enough, but unfortunately the same can’t be said about the changes to the definition of a personal trading company.

Before Budget day, an individual needed to have 5% of the ordinary share capital and 5% of the voting rights of a company in order for it to be a personal company.

From Budget day, they would also need to be beneficially entitled to at least:
• 5% of the company’s distributable profits
• 5% of its assets available for distribution to equity holders in a winding up.

The new legislation is said to be to combat abuse, where individuals hold shares which do not have such a 5% beneficial entitlement, but are “constructed” to comply with the current 5% tests. However, as explained below, it seems possible that the new rules could result in entrepreneurs’ relief being lost in cases where there is no abuse and no artificially constructed arrangements.

The Finance Bill provides that the new tests are to be defined by the “equity holders” tests in the Corporation Tax Act 2010. These tests look at what the individual would receive if there was a distribution or winding up at the time, but then say that if there are no distributable profits, or no assets for distribution, a hypothetical amount of £100 is to be considered. There are some provisions which apply where some shareholders hold shares with limited rights or temporary rights.

This is potentially problematic for entrepreneurs who hold shares in companies which have decided to use growth shares in order to incentivise employees. This is relatively common in a start-up business, where the aim is to incentivise the employees to build up the company to an exit, and the entrepreneur shareholders can then go on to their next project. Growth shares may give their holders an entitlement to a share of proceeds on a disposal of a company where the proceeds are above a specified hurdle.

The 5% test is applied on the basis of a winding-up, and the value of a company on a winding-up will often be below the sale value, for example where the sale price is based on earnings not assets. However, once a sale is completed, proceeds above the hurdle will cause the growth shares to dilute existing shareholders, and this may cause them to fall below 5% at the last minute, denying their expected entitlement to entrepreneurs’ relief.

HMRC have expressed their view that when option-holders exercise their options on the day of sale, this does not dilute the existing shareholders for the purposes of testing whether the company has been their personal company up to the date of disposal, click here. It may be that they will apply a similar approach to growth shares, since the hurdle proceeds don’t arise until the day of disposal.

The position is unhelpful in that although the Finance Bill has provisions to provide relief to shareholders who have qualified for Entrepreneurs’ Relief but are then diluted below 5% by new investment, those provisions have a commencement date of 6th April 2019.

It does appear that entrepreneurs who currently hold 5% of the ordinary shares in a company, where growth shares are being used for commercial reasons as an incentive, could be put into an uncertain position. It is to be hoped that HM Treasury will listen to representations on this point.

We have been researching the position both for entrepreneur shareholders, and for partners investing in a trading group through a partnership with waterfall or carry provisions, and considering practical ways to deal with this. If you would like to discuss the application of this draft legislation to your own potential exit, please contact us at Trident Tax.